‘Of course, you can do better than simply buying equities. During the last bout of significant inflation, commodity equities were a good store of value (unlike the underlying commodities), and so were value stocks in general. Why? Effectively, you were buying cheap real assets. This is like being offered inflation insurance at a discount. So, if you are worried about inflation and looking for a store of value, or you are trying to build a robust portfolio that can survive lots of different outcomes, then buying cheap equities looks like a great place to start.’
The case for value
We acknowledge that it is not easy today to find an asset class which is inexpensive, let alone one which may also provide a hedge against an increase in inflation expectations. However, this is where a value strategy may be useful for two reasons.
Firstly, we believe that low starting valuation is one of the best hedges against rising inflation. Value is one of the few areas that still looks cheap on an absolute basis and hence offers the potential opportunity to make positive real returns over the long term. This is also highlighted by the data in the chart below.
Source: Federal Reserve Bank of St Louis, Sanford Bernstein Research. Data shows cheapest versus most expensive quintile on price to book using monthly average of rolling 5-year annualised returns from 1960 to June 2021.
Since the average stock within the Temple Bar portfolio has an earnings yield of more than 10%, we believe our strategy has one of the best chances to deliver a long-term return that exceeds current rates of inflation. A negatively yielding bond, or an equity with a 2% earnings yield, is much less likely to do that.
Secondly, some of the core value sectors such as energy, materials and financials are those which have historically benefitted during an inflationary environment. Perhaps surprisingly, these sectors are also available at low starting valuations and hence potentially offer a cheap inflation hedge. Given the downside risk to so many asset classes in the event of a rise in inflation, we can see a role for a value strategy in most investors’ portfolios.
